The Symptoms of ZIRP disease
A year ago, the consensus amongst monetary economists and financial pundits was that the uptick of inflation was transitory. We now know that was false. Inflation is now running at approximately 8.6% on an annualized basis, or the highest level since 1981. I hadn’t even been born yet. Even then, inflation was high but decreasing. Now it is high but increasing.
The explanations for our current bout of inflation are many. The pandemic and related supply chain disruptions are certainly a factor. The Russian invasion of Ukraine is another. But we should also consider the easiest explanation: money has been too cheap for too long.
Following the Global Financial Crisis of 2008, the Federal Funds Rate fell to approximately 0% and stayed there until a series of incremental raises beginning in 2016. Even then, the Federal Funds Rate was only raised to about 2.5%.
Though it was always predicted by eccentric cranks (I include myself in this category), throughout this sustained period of basically free money, inflation never really manifested in the CPI data.
The CPI measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. For most of this period, the basket of consumer goods measured by the CPI remained relatively constant, or even declined. The Fed has historically targeted a normalized baseline level of inflation of approximately 2% as part of its dual mandate of price stability and full employment.
The Fed had already been lowering rates by the time the pandemic really hit in early 2020. In hindsight, the Fed had probably been too spooked by the prospect of jittery equity and fixed income markets from about 2018 right up until COVID hit to really commit to a campaign of sustained rate increases. When the global economy shut down in 2020, that really forced their hand. They had to drop rates back to practically zero and engage in an aggressive expansion of the money supply in order to stave off the prospect of even worse mass unemployment and business collapse.
Unfortunately, by the time the pandemic arrived, the Fed didn’t have much room to maneuver. Rates had been kept at a historically low level for so long, that the stimulative effect of dropping rates back to zero was limited at best.
I mentioned that even though rates had been kept at a historically low level for so long, that inflation hadn’t manifested in the CPI data. However, looking back now it’s clear to me that the effects of ZIRP (zero interest rate policy) were evident in other parts of the economy. From 2008 to December 2021, the S&P 500 increased by 224%. The Case Shiller national home price index increased by approximately 100%. Inflation was manifesting itself in asset prices, rather than the price of consumer goods.
There were other symptoms of this ZIRP disease, if you cared to look for them. Do you remember when you first started seeing those Bird scooters strewn about every sidewalk? They actually made their debut in 2017 in Santa Monica, not far from where I work. They quickly spread around the country spawning a series of competitors all seeking the app-enabled credit card swipes of affluent hipsters flitting to and fro, with scant concern for their eye-sore scooters left to litter sidewalks to be picked up and recharged for a pittance by entrepreneurial gig-economy workers. Bird went public via a SPAC (itself a dubious craze of the late ZIRP era) at about $10 a share in 2021. It currently trades at about 47 cents per share, or a loss of about 95% of its IPO valuation.
So much of what we took to be the innovation of the years following the Global Financial Crisis of 2008-2009 turned out to be illusory. The era of practically free ZIRP money propped up any manner of laughable business models. Many of them were supported (at least implicitly) by the painfully slow return to a normalized employment rate. Rideshare companies like Uber and Lyft provided seemingly-affluent millennials and Gen-Z consumers with rides around town that didn’t reflect the true cost of those rides. That largesse was funded by Venture Capital funds and other investors reaching for yield anywhere they could find it, even if it meant underwriting a growth story a with unfavorable unit economics. “We lose money on every ride, but we make it up in volume!” The idea was to establish market dominance by setting large piles of money on fire.
The ZIRP fever may finally be breaking. The haunting specter of (non-transitory) inflation has forced the Fed’s hand. They have moved aggressively to raise rates in home of bringing it back to their normalized target level. They have messaged rates should be expected to continue to increase regularly for the rest of the year. Since the beginning of the year, equities are officially in a bear market. Fixed income markets have similarly traded off. There is evidence that the breakneck pace of home price appreciation is slowing (though it will take time for the effects of higher rates to manifest in listing prices).
It is unlikely that we will soon return to the era of ever rising asset prices that we enjoyed in the 2010s to early 2020s. Much of the late-cycle nonsense (Bird scooters, WeWork, SPACs, waived-contingency-all cash offers, and so many more than I can list here) is mercifully being purged from the system. In hindsight, these will be seen as symptoms of the ZIRP disease, and the recovery period may be painful.